Dear Alex:
I am selling my business and am in the process of negotiating a “Nonbinding Letter of Intent,” which I have to pay my lawyer to do.What’s the point of going through the time and trouble to negotiate this, if it’s not binding on the parties and we still have to negotiate the final contracts down the road? It seems like a pointless expense.
Letters of Intent, or LOIs, also sometimes take the form of a Memorandum of Understanding, or MOU.
Both LOIs and MOUs have the same basic purpose. These documents outline the fundamental terms of a prospective deal, including the price, specific descriptions of what is being bought or sold and the timeline to close the deal.
Sometimes, these documents are binding and have the effect of a contract, obligating the parties to perform according to the terms of the LOI. Other times, they are nonbinding and have the effect of an agreement-to-agree.
In some circumstances, if the parties aren’t careful with how the documents are drafted and presented, an LOI that was initially believed to be nonbinding can be construed as a binding contract.
Particularly with nonbinding letters of intent, clients sometimes feel like they are paying to do the same thing twice — to negotiate the deal for the purposes of the LOI, and to negotiate the deal again later when they are preparing the actual contracts.
While the terms of an LOI are intended to overlap with many of the terms of the final execution-ready contracts, there are significant benefits to the parties’ agreeing upon a nonbinding letter of intent at the initiation of a deal.
Primarily, the LOI serves as a relatively low-cost method of filtering out the “tire-kickers” from serious prospective buyers or sellers. This can save considerable time and expenses.
Additionally, if the most important terms of a deal aren’t laid out explicitly from the start, assumptions are often made as to the other parties’ expectations or intentions, and those assumptions are very often wrong, which can blow up a deal. The very process of drafting and negotiating an LOI helps to cement the parties’ obligations to the deal, reducing the risk of one party walking away from the negotiation table down the line.
Additionally, one party may need to present a prospective deal to lenders, boards of directors, or other third parties whose review and consent to a potential transaction is required before the transaction can be finalized.
With an LOI, these interested third parties are able to get a sound understanding of the terms before the time and expense of negotiating every element of the transaction has been completed. In this way, if those parties are going to reject the deal entirely, or object to specific terms that have been proposed, they are able to do so early in the process.
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